{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

mankiw7e-chap11 - Chapter 11 Aggregate Demand II Applying...

Info icon This preview shows pages 1–13. Sign up to view the full content.

View Full Document Right Arrow Icon
In this chapter, you will learn: how to use the IS-LM model to analyze the effects of shocks, fiscal policy, and monetary policy how to derive the aggregate demand curve from the IS-LM model several theories about what caused the Great Depression Chapter 11: Aggregate Demand II: Applying the IS-LM Model
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Context Chapter 9 introduced the model of aggregate demand and supply. Chapter 10 developed the IS-LM model, the basis of the aggregate demand curve.
Image of page 2
The intersection determines the unique combination of Y and r that satisfies equilibrium in both markets. The LM curve represents money market equilibrium. Equilibrium in the  IS   - LM     model The IS curve represents equilibrium in the goods market. ( ) ( ) Y C Y T I r G = - + + ( , ) M P L r Y = IS Y r LM r 1 Y 1
Image of page 3

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Policy analysis with the  IS   - LM    model We can use the IS-LM model to analyze the effects of fiscal policy: G and/or T monetary policy: M ( ) ( ) Y C Y T I r G = - + + ( , ) M P L r Y = IS Y r LM r 1 Y 1
Image of page 4
causing output & income to rise. IS 1 An increase in government purchases 1. IS curve shifts right Y r LM r 1 Y 1 1 by 1 MPC G - IS 2 Y 2 r 2 1. 2. This raises money demand, causing the interest rate to rise… 2. 3. …which reduces investment, so the final increase in Y 1 is smaller than 1 MPC G - 3.
Image of page 5

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
IS 1 1. A tax cut Y r LM r 1 Y 1 IS 2 Y 2 r 2 Consumers save (1 - MPC ) of the tax cut, so the initial boost in spending is smaller for T than for an equal G and the IS curve shifts by MPC 1 MPC T - - 1. 2. 2. …so the effects on r and Y are smaller for T than for an equal G . 2.
Image of page 6
2. …causing the interest rate to fall IS Monetary policy:  An increase in  M 1. M > 0 shifts the LM curve down (or to the right) Y r LM 1 r 1 Y 1 Y 2 r 2 LM 2 3. …which increases investment, causing output & income to rise.
Image of page 7

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Interaction between  monetary & fiscal policy Model: Monetary & fiscal policy variables ( M , G, and T ) are exogenous. Real world: Monetary policymakers may adjust M in response to changes in fiscal policy, or vice versa. Such interaction may alter the impact of the original policy change.
Image of page 8
The Fed’s response to   G   > 0 Suppose Congress increases G . Possible Fed responses: 1. hold M constant 2. hold r constant 3. hold Y constant In each case, the effects of the G are different…
Image of page 9

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
If Congress raises G , the IS curve shifts right. IS 1 Response 1:   Hold  M   constant Y r LM 1 r 1 Y 1 If Fed holds M constant, then LM curve doesn’t shift. Results: 2 1 Y Y Y = - 2 1 r r r = -
Image of page 10
If Congress raises G , the IS curve shifts right. IS 1 Response 2:   Hold  r   constant Y r LM 1 r 1 Y 1 Y r To keep r constant, Fed increases M to shift LM curve right. 3 1 Y Y Y = - 0 r = LM 2 Y 3 Results:
Image of page 11

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
IS 1 Response 3:   Hold  Y   constant Y r LM 1 r 1 Y r To keep Y constant, Fed reduces M to shift LM curve left. 0
Image of page 12
Image of page 13
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}